What Will the Debt Deal Mean for Tax Reform?

What will the debt deal mean for the future of tax reform? Sadly, nothing good.

The budget agreement is, for tax reformers, a huge disappointment. It is based on the fantasy that the nation can return to a sound fiscal footing through spending cuts only. It entirely ignores the revenue side of the budget. And while a special bipartisan congressional committee representing both the House and Senate (to be called the Gang of 12, I suppose) would have the authority to recommend tax reform later this year, there is no reason to believe it will do so.

Indeed, because the debt deal will limit the ability of Congress to spend money directly, it is likely to encourage lawmakers to expand their use of tax subsidies. Instead of reform, this will only accelerate the trend towards what my Tax Policy Center colleague Gene Steuerle likes to call tax deform.

The new bipartisan deficit committee is set up, in fact, to make it as difficult as possible to fundamentally rewrite the tax code. The panel would be required to find about $1.5 trillion in deficit reduction over 10 years. In theory, it could get the money through either spending or new taxes. But if Congress fails to adopt the panel’s recommendations (assuming it can even agree on a package), the consequence is $1.2 trillion in automatic spending cuts only. Taxes would be exempt from this step.

It is impossible to believe the GOP members of this committee would agree to new revenues. They might support a restructuring that ends some tax preferences and lowers rates but keeps total revenues about where they are (ala the Tax Reform Act of 1986). But the debt deal makes even that difficult.

Here's why: The $1.5 trillion deficit reduction target will presumably be measured relative to current law, which assumes the 2001/2003/2010 tax cuts expire at the end of next year. As a result, any changes Congress makes in the Bush/Obama rates would probably be scored by the Congressional Budget Office as a tax cut and only add to the deficit.

As for the Democrats, it is hard to imagine that after the concessions they just made on spending, their panel members would buy into any tax reform unless it reduces the deficit.

A basic rule of tax reform: It will go nowhere if the parties can’t agree on the ground rules. And Rule #1 is lawmakers must determine whether reform should be a revenue-raiser or revenue-neutral. Unless it can settle that issue (and it can’t), the panel is very likely to simply leave taxes out of its plan entirely.

The other opportunity for near-term tax reform could come with the expiration of the Bush/Obama tax cuts in December, 2012. President Obama could use that deadline as leverage for reform and, if he laid out a bold plan, might even pull it off. But such an aggressive step isn’t Obama’s governing style. After all, he blinked when the GOP called his bluff on extending the 2001 and 2003 tax cuts last December. There is no reason to believe he’ll act boldly in the midst of his reelection bid.

It is very likely that in the end everyone will be disappointed by the debt deal. Republicans will realize it imposes far fewer spending cuts than they think. In truth, it would trim the discretionary budget in 2012 by either $25 billion or $45 billion (depending on what you want to measure it against). While this will mean painful cuts in some programs, it would reduce total federal spending by only about one percent.

After next year, all additional non-entitlement cuts would be made at the discretion of future Congresses. And those lawmakers could easily finesse their way out of the triggers and caps in this deal. Past history shows that after just a few years of budget-cutting, Congress (and the public) loses its stomach for painful spending reductions.

But as disappointed as the GOP will be in the spending reductions, nobody will be as frustrated as the tax reformers. Yet another golden opportunity seems to have slipped through their grasp.

Posts and Comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.